The Internal Revenue Service (IRS) recently published updates to the compliance monitoring and utility allowance regulations. The compliance monitoring regulation update outlines a major change in the requirements relative to the property review protocol to be followed by Housing Finance Agencies (HFAs). The utility allowance regulation revisions relate primarily to the submetering of energy acquired from a renewable source and HFA approval of professional engineers. Here are highlights of the details relating to both regulations.
Amendments to LIHTC Monitoring Regulation, Revenue Procedure 2016-15
In February, the IRS published a proposed rule in the Federal Register that would amend the compliance monitoring duties of a state or local housing credit agency relative to the Low-Income Housing Tax Credit (LIHTC) Program. The regulation will revise and clarify certain rules relating to the requirements to conduct physical inspections and review low-income certifications and other documentation. Comments on the proposed regulation were due by May 25, 2016.
Simultaneously with publication of the proposed rule, the IRS issued Revenue Procedure 2016-15. That procedure stipulates the minimum number of low-income units in a low-income housing project for which an HFA must conduct physical inspections and low-income certification reviews. The procedure also permits the physical inspection protocol established by the U.S. Department of Housing and Urban Development (HUD) for Real Estate Assessment Center (REAC) inspections to be accepted by HFAs for purposes of the Section 42 physical inspection requirements.
In order to qualify under the LIHTC program, a unit must be rent-restricted, occupied [or last occupied] by a qualified low-income household, suitable for occupancy and used other than on a transient basis. The suitability of occupancy is determined by taking into consideration local health, safety and building codes.
Failure of one or more units to qualify as low-income units may result in a low-income housing project’s ineligibility for the LIHTC, reduction in the amount of credit and/or recapture of previously allowed credits.
IRS Regulation 1.42-5 requires an agency to conduct onsite inspections and perform low-income certification reviews (including documentation supporting the low-income certifications and the rent records for the tenants) for each low-income housing project.
The regulation requires an agency to conduct onsite inspections of all buildings in a low-income housing project and review low-income certifications by the end of the second calendar year following the year the last building in the project is placed in service, and at least once every three years thereafter.
The regulation stipulates that the IRS may provide alternative means of meeting the review and inspection requirements, and may provide exceptions to the requirements. However, the HFA must inspect no fewer than the minimum number of low-income units required by the IRS regulation.
The current regulation requires the HFA to select the low-income units for inspection in a random manner. The manner used for selection must not give advance notice that a low-income unit or low-income certifications for a particular year will or will not be inspected or reviewed. The HFA may give an owner reasonable notice that an inspection and review will occur so that the owner may notify tenants of the inspection or assemble certifications for review.
A major change in the regulation is that the IRS no longer requires that an agency select the same low-income units for onsite inspections and certification reviews. If the HFA chooses different low-income units for physical inspections and certification reviews, the units must be selected separately and in a random manner. An HFA may choose a different number of units for physical inspection and certification review, as long as at least the minimum number of low-income units is chosen in each case.
No matter whether there is overlap or non-overlap of selected units, except for reasonable notice, there should be no advance notification of the units to be inspected. The IRS position is that advance notice generally means no more than 30 days. Therefore, if an HFA chooses to select the same units for both physical and file inspections, the physical and file reviews may be done at the same time or separately, as long as both are done within the reasonable notice period.
The period begins on the date the HFA informs the owners of the identity of the units for which the physical and file review will occur.
Number of Low-Income Units for Inspection & Low-Income Certification Review
The new procedure gives HFAs substantial leeway with regard to the number of units to be reviewed. The minimum number of low-income units for which an agency must conduct physical inspections and file reviews is the lesser of: 20% of the low-income units in the project rounded up to the nearest whole number of units, or the minimum unit sample size set forth in the following chart.
This protocol significantly reduces the workload for HFAs – especially on larger properties. Under the prior regulation, a property with 250 units would require an HFA review of at least 50 units. Based on the new system, the same size project requires a review of only 24 units. Even if the HFA reviews 24 different units for purposes of files and physical inspections, a total of only 48 units would have to be reviewed.
The REAC protocol is among the inspection protocols that satisfy all Section 42 physical inspection requirements. To be acceptable, the inspection must satisfy all of the following requirements:
- Both vacant and occupied low-income units in a low-income project must be included in the population of units from which units are selected for inspection.
- The inspection must comply with all requirements of the HUD REAC, including use of the most recent HUD Uniform Physical Condition Standards (UPCS) inspection software.
- The inspection must be performed by HUD REAC-approved inspectors.
- The inspection results are sent to HUD, and the results are reviewed and scored within HUD’s secure system without any involvement of the inspector who conducted the inspection. HUD makes its inspection report available.
If the REAC inspection is used, the requirement that all buildings be inspected is removed, and the number of units inspected based on the REAC protocol will be acceptable (i.e., the number of units inspected does not have to match the 1.42-5 sampling size requirements noted above). Also, the manner in which the units are selected for inspection under the REAC protocol will be accepted. The agency still will have to conduct the review of tenant certifications.
The revenue procedure became effective Feb. 25, 2016. Agencies using the REAC protocol as part of the Physical Inspections Pilot Program may rely on these provisions for on-site inspections and low-income certification review occurring between Jan.1, 2015 and Feb. 25, 2016.
Utility Allowance Final and Temporary Regulations
The IRS published Final and Temporary Regulations relating to Utility Allowances for LIHTC properties in the March 3, 2016 Federal Register.
The final regulations clarify the circumstances in which utility costs paid by a tenant based on actual consumption in a submetered rent-restricted unit are treated as paid by the tenant directly to the utility company. The regulation extends the principles of the submetering rules to situations in which a building owner sells to tenants energy that is produced from a renewable source and that is not delivered by a local utility company.
On Aug. 7, 2012, the IRS published a Federal Register notice of proposed rulemaking that provided that utility costs paid by a tenant based on actual consumption in a submetered rent-restricted unit are treated as paid by the tenant directly to the utility company and thus do not count against the maximum rent that the building owner can charge. In these cases, the owner may establish a utility allowance in accordance with the IRS utility allowance regulation 1.42-10 for submetered utilities.
This final regulation adopts the 2012 proposed regulation and extends those rules to the provision of energy that the building owner acquires directly from renewable sources and then provides to low-income tenants (e.g., solar energy sources).
Actual-Consumption Submetering Arrangements and Ratio Utility Billing Systems (RUBS)
The 2012 proposed regulations defined an actual-consumption submetering arrangement for utility allowance purposes as not including a ratio utility billing system (RUBS). The regulations precluded an arrangement such as RUBS from qualifying as an actual consumption submetering arrangement. It should be noted that the regulation did not prohibit the use of RUBS for low-income housing credit projects. However, any amount paid by a tenant for utilities using RUBS must be included in gross rent and may not be part of the utility allowance.
- NOTE: The final regulations follow this approach and continue to define an actual-consumption metering arrangement as not including RUBS.
Administrative Cost of Submetering
a. The final regulations do not include a requirement to determine actual monthly cost of administering the submetering program, and they generally permit owners to charge tenants an administrative fee in accordance with a state or local law that specifically prescribes a dollar amount for the administrative fee. The regulation authorizes the Department of Treasury and the IRS to provide for administrative fees in excess of five dollars per month, even in the absence of state or local law doing so, and to put an upper limit on administrative fees even if state or local law allows higher fees.
- The proposed regulation limited the fee charged per unit to the lesser of five dollars per month, or the owner’s actual monthly cost paid or incurred for administering the arrangement.
b. If a building owner or its agent charges a unit’s tenants a fee for administering an actual-consumption submetering arrangement, the gross rent includes any amount by which the aggregate amount of monthly fees for all of the unit’s utilities under one or more actual-consumption submetering arrangements exceeds the greater of five dollars per month; an amount (if any) designated by publication in the Internal Revenue Bulletin; or the lesser of a dollar amount (if any) specifically prescribed under a state or local law or a maximum amount (if any) designated by publication in the Internal Revenue Bulletin.
[This essentially permits owners to charge more for administrative fees than permitted under this regulation, but any charges in excess of those permitted must be included in gross rent].
- Energy Acquired Directly From a Renewable Source
a. The proposed regulation appeared to preclude applying submetering principles to electricity generated from renewable sources by the building owner or by some other person from whom the building owner purchases it directly.
b. This regulation contains temporary regulations that apply those principles to energy that the building owner provides to tenants after having acquired it directly from renewable sources.
- However, in such cases, charges to the tenants for this energy must be comparable to local utility rates. Charges by the building owner must not exceed the rates that the local utility company would have charged the tenants if they had instead acquired the energy from that company. For example, if an owner charges residents for electricity generated by solar power, the amount charged may not exceed the amount the residents would pay for electricity provided by the local utility company.
Issues Relating to Utility Allowances Generally
- Role of Agencies Regarding the Utility Allowance Methods
a. A significant change with regard to the state agency’s role in the final regulations is that agency approval will be required only for qualified professionals that are not properly licensed engineers. [The current requirement is that the agencies approve both qualified professionals and licensed engineers.]
- An agency continues to have the option to review, and take appropriate action regarding, utility estimates based on the energy consumption model or the other optional methods.
b. The regulation continues to allow an agency to approve or disapprove a method, or to require certain information before permitting use of an energy consumption model. Also, an agency should have the ability to review the energy consumption model even when a properly licensed engineer, who is not subject to agency approval, uses the model. The final regulations specifically authorize an agency to approve or disapprove use of the energy consumption model or require information about the model before permitting its use, regardless of the type of professional who calculates the utility estimates.
Use of Consumption Data for the Energy Consumption Model
The final regulations remove the requirement that an energy consumption model use the building’s consumption data for a particular 12-month period. Instead, the final regulations revise the specific factors used in determining estimates under the energy consumption model to include available historical data. This is due to the fact that the most recent 12 months of utility data (required under the current regulation) may not be representative of actual consumption.
3. Areas with No Public Housing Authorities
The existing regulations provide that if a building is neither a Rural Housing Services (RHS)-assisted building nor a HUD-regulated building and no tenant in the building receives RHS tenant assistance, then the appropriate utility allowance for the units in the building is the applicable Public Housing Authority (PHA) utility allowance. This creates problems in areas where there is no local PHA. This Notice does not address the issue, but the IRS is requesting comments on how the rules might best address situations in which no PHA exists.
4. Changes in PHA Utility Allowances
The final regulation retains the requirement that if a PHA utility allowance changes, the building owner must use the new utility allowance to compute gross rents of the units, due 90 days after the change. In other words, the 90-day period ends 90 days after the effective date of the revised PHA allowance. In the regulation, the IRS states that “A building owner that checks the PHA utility allowance every 60 days would have at least 30 days in which to adjust rents.”
5. HUD-Regulated Building
Existing regulations defined a HUD-regulated building as one for which HUD reviews the rents and utility allowances on an annual basis. Since HUD does not review rents and utility allowances on an annual basis for all programs, the final regulations define a HUD-regulated building to mean one in which the rents and utility allowances of the building are regulated by HUD (with no requirement for an “annual” review).
Owners may use the revised regulations on or after March 3, 2016. A building owner may apply the regulations to taxable years beginning prior to March 3, 2016, but are not required to do so. They may continue to use the regulations contained in IRS Regulation 1.42-10 for taxable years beginning prior to March 3, 2016. For example, if an owner’s taxable year began Jan. 1, 2016, they may use the IRS utility allowance regulation published on March 3, 2016 or the regulations in effect prior to March 3, 2016. However, beginning on Jan. 1, 2017, the new regulation will have to be used.
Summary of Major Changes
- Owners may sub-meter units for utilities that owners obtain directly from renewable sources instead of from utility providers.
- The maximum administrative fee that may be charged for submetering is changed from the lesser of $5 per month, or the owner's actual monthly costs paid or incurred for administering the arrangement, to the greater of $5 per month; an amount designated by the IRS; or the lesser of a dollar amount specifically prescribed under state or local law or a maximum amount designated by the IRS. If a fee in excess of the permitted amount is charged, it must be included in gross rent.
- Owners are no longer required to have HFA approval when using a licensed engineer in the preparation of a utility allowance (HFA approval for other qualified professionals is still required). Agencies still have the ability to review and take appropriate actions relative to utility allowance estimates prepared by licensed engineers.
- Removes the requirement to use data from a particular 12-month period when using a consumption model, and instead requires use of available historical data.
- Eliminates the requirement that HUD-regulated buildings be those for which HUD reviews the rents and utility allowances on an annual basis. The requirement now is only that the building be HUD-regulated.
A.J. Johnson is president of A.J. Johnson Consulting Services, Inc., a full service real estate consulting firm specializing in due diligence and asset management issues, with a particular emphasis on properties utilizing the Low-Income Housing Tax Credit. Johnson is a nationally recognized speaker on many areas related to the real estate industry and the author of A Professional Property Manager’s Guide to the Low-Income Housing Tax Credit – now in its eleventh edition –specifically written to assist site and property managers in maintaining tax credit compliance.